For the New York Times columnist, the recent surge in food and energy prices is an indication that we are running out of resources. But with speculators driving up commodity prices across the board, our most immediate concern should not be Krugman’s finite world, but Goldman’s financialized world.
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Paul Krugman is at it again. Two years after causing a public stir by claiming that the 2007-’08 oil price hike was the result of changing Chinese consumption patterns, not of financial speculation, the Nobel Prize-winning economist seems to have lost little of his self-declared liberal stubbornness.
In an op-ed in the New York Times last week, Krugman again assailed those observers who take speculators to be behind the 34 percent surge in the oil price since May 2010. For Krugman, rising commodity prices — including those for copper, cotton, wheat and corn — are an indication not of “speculation run amok,” nor a “harbringer of runaway inflation.” Rather, they are a sign that:
… we’re living in a finite world, in which the rapid growth of emerging economies is placing pressure on limited supplies of raw materials, pushing up their prices. And America is, for the most part, just a bystander in this story.
Unfortunately for Krugman, repeating a falsehood twice doesn’t make it right. Neither does invoking a truism — “we live in a finite world!” — help in overcoming the grave dangers posed by a financialized global economy. In fact, America (and Europe, by implication) is at the very heart of this story, with Goldman Sachs and City bankers threatening to push the global economy over the precipice once again with their next bout of reckless speculation.
Krugman said pretty much the exact same thing back in 2008. When oil was trading at $135 a barrel, he spoke of “speculative nonsense,” and asked skeptics to “drop all the talk about an oil bubble.” In fact, the whole debate was driving him so mad, it just made him “want to shoot someone in the face.“
Just a few months later, the oil price suddenly collapsed to $40. Most economists — with Krugman as the notable exception — seemed to recognize that speculation had been the driving force behind the unprecedented hike in food and energy prices. After all, virtually everyone agreed that it was rather phantasmal to ascribe a threefold drop in the oil price to a mere six percent drop in global oil consumption.
Yet for some reason, Krugman continued to argue for an old-fashioned focus on the fundamentals of supply and demand. For Krugman, the real driver behind the 2007-’08 and 2010 price surges was changing consumption patterns in China and other emerging economies — a development with which “supplies aren’t keeping pace.”
But in an excellent piece in The Independent, entitled How Goldman Gambled on Starvation, Johann Hari correctly defeats this point in reference to the 2007-’08 food crisis:
How do we know this is wrong? As Professor Ghosh points out, some vital crops are not traded on the futures markets, including millet, cassava, and potatoes. Their price rose a little during this period – but only a fraction as much as the ones affected by speculation. [Ghosh's] research shows that speculation was “the main cause” of the rise.
What we are witnessing today is, in essence, a replay of what happened in 2007-’08, when investors panicked to get out of the collapsing U.S. real estate market and fled en masse into ‘safe’ investments like commodities. Right now, with the collapse of Eurozone closer than ever before, and a looming municipal debt crisis in the U.S. — where more than 100 cities are facing over $2 trillion in debt — investors are right to be anxious.
Yet the world economy remains awash in excess liquidity following the bankers’ extravagant bailout packages, and this surplus capital has to flow somewhere. In such an uncertain financial climate, commodities are always a safe bet. In fact, when combined with the neo-Malthusianzeitgeist, they are not just an excellent choice for hedging, but also a wonderful speculative investment. After all, experts left and right — including Krugman — are promising that renewed scarcity will send prices up into the skies far into the foreseeable future.
As a result, we can be certain of the fact that it was speculation that drove up the oil price. Research by “hedge fund honcho” Michael Masters shows that, in the first months of 2008, over $60 billion was invested in oil, pushing the price per barrel from $95 to $147. By September, speculators had already withdrawn $39 billion of their initial investments, precipitating the unprecedented threefold drop in the oil price.
To understand what is really going on, we have to take into consideration what is happening in other commodity markets as well. Just a few months back, the Food and Agricultural Organization of the United Nations in Rome warned of another impending food crisis in 2011, the two principal causes of which will be climate change and food speculation.
This crisis is now beginning to materialize, as climate shocks in Russia, Pakistan, Australia and Argentina have conspired with rampant food speculation to cause food prices to rise to their highest levels in recorded history.
Similarly, precious metals are booming. The London Metal Exchange surged from 1600 points to 4164 points in just two years. The price of gold shot up 30 percent in 2010 alone. How do we account for this? Have the Chinese suddenly developed a craving for wedding rings? Is the Nigerian fascination with golden teeth starting to exhaust our reserves?
Clearly, this rather simplistic demand-side explanation cannot capture the complex dynamic of commodity market price volatility. In order to find out what’s really going on, we have to look at who’s gaining from all of this. The answer is fairly unsurprising: hedge funds. The Regent Fund of London’s 36 South, for example, which invests in gold futures, gained 96 percent in 2010. Its Alegra ABS Fund, which invests in mining companies, grew 93 percent.
In fact, something fascinating happened on April 27, 2010, when Standard & Poor cut Greece’s credit rating from BBB+ to BB+. As S&P relegated Greek bonds to ‘junk status’, thereby precipitating the climax of the Eurozone debt crisis, the price of gold instantly racketed up with $25. According to MoneyWeek:
In these circumstances [of sovereign debt crisis], where’s left for money to flee to? Gold’s unique selling point is that it is nobody else’s liability. That’s what should make it an attractive buy when the world’s financial system comes under this sort of stress.
The fact that gold is trading well over $1400 per troy ounce is just one more indication that “crude and commodity bullishness are at dangerous highs and a pullback is near.” Rightly so, traders are now beginning to warn regulators of a major speculative bubble in commodities.
As such, the greatest danger in Krugman’s analysis is not his factual error in ascribing the recent surge in commodity prices to changing consumption patterns in China — but rather the moral and strategic consequences that this factual error implies.
By literally stating that “this is a global story; at a fundamental level, it’s not about us,” Krugman risks shifting the blame, and therefore the burden of adjustment, squarely onto the shoulders of poor citizens in emerging economies — who actually played a negligible role in causing the crisis.
Also, by arguing that rising energy prices are an indication that we live in a ‘finite world’, Krugman risks gambling all the credentials of the energy transition on a single horse: the unabated rise of energy prices far into the foreseeable future. Yet what will happen when the bubble bursts and the price of oil falls back to $60 a barrel? One of Krugman’s main arguments for a clean energy transition will simply evaporate.
As such, what is the value in stating the obvious? Everyone knows that the world is finite and we will run out of oil sooner or later. The big question, however, is how to bring about an equitable transition in which, as we say in Dutch, the strongest shoulders carry the heaviest burden.
From this perspective, blaming Chinese “overconsumption” for the price rises caused by the extravagance of our own bankers is not only factually wrong — it is strategically dangerous and morally reprehensible.